Fed to do what it can to ease cliff uncertainty

Central bank may maintain steady pace of $85 billion in asset buys

WASHINGTON (MarketWatch) — The Federal Reserve is set to take more action this week to support financial markets and the economy, as the central bank tries to stay predictable given all the uncertainty surrounding the fiscal cliff.

To accomplish this, the Fed may announce fresh monthly purchases of $45 billion of Treasurys, economists say. These new purchases will start in the new year after the existing Operation Twist bond-buying program expires.

U.S. Federal Reserve Chairman Ben Bernanke speaks to the Economic Club of New York in New York, November 20, 2012.

Under Twist, begun in September 2011, the Fed offset $400 billion of Treasury purchases with sales of shorter-term debt on its balance sheet.

While on the outside, the Fed wants to give the appearance of a steady hand on the tiller, behind closed doors it is another story.

“I think they are terrified of the fiscal cliff,” said Joseph Gagnon of the Peterson Institute for International Economics.

“They are pretty sure there would be a recession if there is no deal,” he said.

In January, $500 billion in automatic tax increases and spending cuts will begin if Congress doesn’t intervene. A complete collapse in the talks lasting for weeks could lead to a recession, according to the Congressional Budget Office. Read MarketWatch’s Political Watch blog report

Although pleasing to markets because it was not a disaster, “bottom-line...it is clear that the rate of job growth remains disappointingly slow in most sectors of the economy. This leaves the economic recovery uncomfortably vulnerable to adverse shocks coming from U.S. fiscal policy and slowing growth from abroad,” said Scott Anderson, chief economist for Bank of the West.

“The best thing the Fed can do is to show a steady hand,” said Jim Glassman, economist at JP Morgan Chase.

Josh Shapiro, chief U.S. economist at MFR Inc, said the central bank’s goal is to not make policy “less expansionary.”

With the Fed also buying $40 billion of mortgage-backed bonds in an open-ended program, the purchases to replace Twist will keep the Fed buying a total of $85 billion of assets per month. The central bank is also expected to repeat it expects to hold interest rates near zero until at least mid-2015.

Continuation of the purchases is widely expected as economists think the Fed will not want to disappoint traders.

“They don’t want to do anything the market takes as a negative,” said Avery Shenfeld, chief economist at CIBC World Markets.

The Fed views the potential harm from disappointing the market as more damaging than possibly overdoing the amount of asset purchases, Shenfeld added.

The Fed has deliberately not set an end date for the purchases, saying only they will continue bond buying until there is substantial improvement in the labor market.

If the purchases last all year, the Fed could be adding $1 trillion to its balance sheet.

This is probably the “upper bound” of what the Fed has in mind, Gagnon said. The purchases will likely last a minimum of six more months, he predicted.

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